Why can’t the Fed predict recessions? 4 reasons

Opinion: 2008 transcripts show inflation obsession, bias to sugarcoat

Fed chief Janet Yellen says the recent softening in the economic data haven’t changed her view that the economy is gradually improving.

WASHINGTON (MarketWatch) — There’s no question that the economy has softened in recent months, but policy makers at the Federal Reserve tell us not to worry, that it’s mostly just bad weather and the normal ups and downs of the economic data.

But what if they’re wrong? Would they tell us if they thought we were heading for a new recession? Could they bring themselves to tell us if they did think it?

The experience of the last recession, which started at the beginning of 2008, is telling. Although the Fed began cutting interest rates months before the recession began and continued to cut rates aggressively throughout 2008, policy makers were reluctant to use the “R” word, even in private, according to the recently released transcripts of the meetings of the Federal Open Market Committee.

While most policy makers had recognized by March that the economy was in a recession, they didn’t grasp the magnitude of the disaster until it was too late. Most of them thought the recession would be shallow and brief. Most of them thought the Fed would begin raising interest rates very quickly once the storm passed. They were wrong.

MarketWatch

In the middle of 2008, Fed officials had a hard time seeing just how severe the recession was going to be. They thought GDP was rising, but actually the economy was contracting.

Why can’t the Fed predict recessions? Here are four main reasons.

Garbage in, garbage out

Like many of us, the Fed relies on a flow of economic data. But what happens if the data aren’t accurate, reliable or timely?

In August 2008, just before the financial crisis climaxed, most Fed policy makers thought the economy had avoided the worst, in part because of misleading data.

In particular, the Fed thought the economy’s gross domestic product had grown at a 1% rate in the first quarter and 1.9% in the second quarter. But revisions to GDP have been dramatic: We now think the economy contracted 2.8% in the first quarter before rebounding 2% in the second quarter.

They thought the economy was growing modestly, but it was contracting. The economy dropped 2% in the third quarter and an incredible 8.3% in the fourth quarter.

Other data the Fed was looking at were closer to the truth. At the time, they thought nonfarm payrolls had fallen by a total of 831,000 in the first seven months of the year and that the unemployment rate had risen by 0.8 percentage points. Now we know it was a little worse than that: 944,000 lost jobs. But at least labor market indicators were pointing in the right direction.

Why China’s Yuan Is Falling

(4:13)

China’s central bank is deliberately pushing the yuan down to prepare the currency for wider trading. Geoff Kendrick, head of Asian foreign exchange and rates strategy at Morgan Stanley, spoke to the WSJ’s Jake Lee about the RMB moves.

Whistling past the graveyard

Fed officials live in a world where one ill-chosen word can tank markets in an instant. They adopt a circumspect approach to communication. They are careful not to shout “fire” because they don’t want to sow panic.

Is that reluctance to shout “fire” also making it harder for Fed officials to spot fires?

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